"The new big Hollywood movie, The Wolf of Wall Street, may have investors taking a second look at that stack of trade confirmations that come piling in each month," says securities lawyer Lars Soreide. How can an average investor learn if their stock broker is churning their account? The word "churning" is defined by the Securities and Exchange Commission (SEC) as excessive buying and selling in securities in a customer's account chiefly to generate commissions that benefit the broker. Not all frequent buying and selling is churning, and there are actual tests spelled out in SEC rules and case law which provide clear tests for whether or not a customer's account has been churned.
"Turnover" is the term used to describe the calculation to see if your account has been churned. For example if you have $100 in securities and your broker buys $1000 in securities over the course of a year, the turnover in your account is 10. (1000/100 = 10). The Securities and Exchange Commission (SEC) has found a turnover ratio of 3.3 to be excessive for some investors. (See In the matter of Studer and Capital Securities Corp., SEC Release No. 50534A (November 30, 2004); Gerald E. Donnelly, 52 SEC 600, 602 n. 11 (1996) noting that respondent acknowledged that "an annualized turnover rate of between two and four is presumptive of churning"; Hume, 52 SEC 245, n.5 noting that turnover rates of 3.5 and 4.4 were found to be excessive in past cases; Reynolds, 50 SEC at 808 n.12 finding excessive trading, in part based on the fact that the account was turned over more than 4 times on an annualized basis; Samuel B. Franklin & Co., 42 SEC 325, 330 (1964) finding turnover rate of 3.5 to be excessive). The courts which have addressed this issue have indicated that annual turnover rate in excess of 6 reflects excessive trading. (Arcenaux v. Merrill Lynch et al., 767 F.2d 1498, 1502 (11th Cir. 1985). See also Laney v. American Equity Investment Life Ins. Co., 243 F. Supp 1347, 1355). This is a simple calculation that can be done by every investor. Look at the first page of each account statement which shows the total amount of securities bought and sold each month.
The Securities & Exchange Commission has concluded that a broker's excessive trading in a customer's account may violate the suitability rule. (Rafael Pinchas, 54 S.E.C. 331, 342 (1999); see also John M. Reynolds, 50 S.E.C. 805, 806 (1991) (stating that "excessive trading may be thought of as quantitative unsuitability"). Churning is not suitable, and unsuitable investments can also give rise to claims of liability against your broker. Excessive trading occurs when a broker has control over trading in a customer account and the level of activity in that account is inconsistent with the customer's objectives and financial situation. (Pinchas, 54 S.E.C. at 337). A broker who does not have formal discretionary authority over an account may still exercise de facto control of the account. (Reynolds, 50 S.E.C. at 807-808). De facto control exists where a customer relies on a broker's advice to such a degree that the customer does not independently evaluate the broker's recommendations and exercise independent judgment. (See Tiernan v. Blyth, Eastman, Dillon & Co., 719 F.2d 1, 3 (1st Cir. 1983); Follansbee v. Davis, Skaggs & Co., Inc., 681 F.2d 673, 676-77 (9th Cir.1982); Mihara v. Dean Witter & Co., 619 F.2d 814, 821 (9th Cir. 1980). Such reliance can be established by evidence that the customer is unsophisticated and routinely followed the broker's advice. (Clyde J. Bruff, 53 S.E.C. 880, 883 (1998); see Mihara, 619 F.2d at 821; see also Cruse v. Equitable Sec. of New York, Inc., 678 F. Supp. 1023, 1030-1031, (S.D.N.Y. 1987) ("Although a securities account may be non-discretionary, a broker may still effectively exercise de facto control where a customer places his trust and faith in a broker and routinely follows his broker's advice.") (citing Mihara, 619 F.2d at 821)).
So if your account has been churned, what damages may you be entitled too? The method of calculating damages for a churning case can be found in the landmark opinion of Miley v. Oppenheimer, 637 F.2d 318 (5th Cir. 1981). The Miley case settled the issue of how to compute damages in a churning case such as this one where the brokerage firm earns outrageous commissions through excessive markups and his churning in unsuitable securities causes devastating losses. Miley specifically allows recovery for both the commissions charged and the loss in account value caused by the churning in issue.
Attorney Lars Soreide of the Soreide Law Group, represents churning victims nationwide before the Financial Industry Regulatory Authority. If you feel your stock broker or financial advisor has churned your account and generated excessive commissions at the expense of your savings call (888) 760-6552 for a free consultation. You can learn more about our firm at http://www.SecuritiesLawyer.com. All consultations are free and there is no fee if there is no recovery.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.